Stocks & Commodities V. 32:2 (22-26): The Weekly Options, Part 2 by John A. Sarkett

The Weekly Options, Part 2 by John A. Sarkett

To Adjust Or Not To Adjust

Last month in part 1, we tracked the growth in weekly options and presented one trader’s success story trading AAPL iron butterflies. Here, we look at three more ways to trade weeklys.

Sheridan Options Mentoring (SOM) community member Leo Andrade trades Apple (AAPL) weeklys but in a somewhat different manner from fellow SOM community member Ed Tulauskas, whom I profiled in part 1.

Andrade puts on his weekly Apple (AAPL) trade (an iron butterfly) on Thursday (eight days to expiration) and Monday (four days to expiration). The risk curve of an AAPL iron butterfly is displayed in Figure 1. Currently, he favors the four-day trade because the increased volatility of late in AAPL made holding the longer trade riskier. He puts on his trade at-the-money with 20 wide wings, similar to what Tulauskas does (although the width will sometimes vary depending on the implied volatility of the at-the-money options). His normal iron butterfly has 30 contracts.

He aims to collect between $8 and $11 credit, depending on the then-implied volatility. If the initial spread has too much negative delta, he may add insurance in the form of an at-the-money call in the next expiration. However, he prefers to go into the next trading day slightly short delta. He does a fire drill (a phrase that SOM founder Dan Sheridan coined for a process he uses) in the last half hour of each day, analyzing possible outcomes for tomorrow’s open, and taking appropriate defensive steps. For example, he may buy one or more nextexpiration at-the-money puts to keep his delta slightly negative, that is, he leans into the pain — the negative vega.

Andrade primarily uses next-expiration puts and calls to control the delta of the trade. He will, however, adjust delta hesitantly since the price of AAPL has a tendency to whipsaw. Since he works from home, he is able to watch his trading screen while the market is open, so he uses judgment and experience instead of mechanical triggers to make adjustments to the original trade. He does set alerts at halfway between the short strikes and the breakeven points but doesn’t necessarily make adjustments when those points are reached.

Let’s say Apple does move higher. How does Andrade adjust? Initially, he prefers to buy a next-expiration call or calls to cut the delta at least in half. If the move up is particularly aggressive, especially if it’s an opening gap, he may buy in some or all of his short calls. When he senses AAPL has run its course or if it retraces, he will reestablish the call spread in the iron butterfly at the same or higher strikes.

If AAPL approaches his upper breakeven early in the trade — for example, Monday or Tuesday — he may roll up his call spread three or four strikes, converting the trade into an iron condor (a common adjustment at SOM for many butterfly traders). This adjustment gives a wider range for AAPL to move through and still stay within the trade’s expiration breakeven points. The drawbacks of this adjustment are: